High Cost to Focusing on Student Loans Over Saving

This week, President Obama ordered changes to the federal student loan program that could help millions of borrowers make their payments more affordable starting in December 2015.

In a short speech in which he used the word “outrage” twice, he noted that he and his wife, Michelle, paid off their own student loan debt only 10 years ago, when they were already saving money for their daughters’ college educations.

This household tug of war for every dollar a family earns has not been a big part of the discussion of the long-term impact of the trillion-dollar student loan debt overhang. And the Obamas are well off enough now that they no longer have to choose between repaying debt or saving for a down payment, college or retirement.

Most Americans, however, must prioritize. And even those with average student loan debts may end up sacrificing hundreds of thousands of dollars of retirement savings if early in their careers they devote themselves to repaying student loan debt without saving for anything else.

It’s hard for new college graduates — let alone teenagers making the initial borrowing decisions — to wrap their heads around this possibility when the shortfall is 40 or 50 years away. The whole world is telling them that they should go to college, and they should. But taking on debt to do so leads hundreds of thousands of new graduates each year to forgo saving money for years afterward. The long-term cost ought to be part of the bigger conversation.

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CreditDrawing by Robert Neubecker

Here’s how the cost of delaying savings would break down, according to a scenario that Vanguard helped me prepare and compute. Assume that two people graduate from college in the same year and get a job earning the same $45,000 salary, with equal raises over time. (Let’s stop here to allow for the fact that plenty of people take on debt without ever graduating, and plenty more get their degrees but end up in low-paying jobs that don’t require one.)

One individual has a pile of student loan debt and spends the next 10 years single-mindedly paying it down before saving anything for retirement. The other starts saving 4 percent a year (plus an annual 4 percent employer match) and increases it by a percentage point each year until reaching the $17,500 annual pretax maximum that the federal government sets for workplace retirement savings plans. The person with the debt starts saving the same amount at the same rate at age 32, once the student loan balance is zero.

Both people earn 5 percent annual returns on their investments over time. By the time the pair turn 65, the individual with the 10-year head start will have $1,829,571 in a retirement account in today’s dollars. That’s $396,039 more than the $1,433,532 in the account that belongs to the person who spent a decade paying off student loan debt before saving.

A year ago, Robert Hiltonsmith, a policy analyst at the liberal public policy organization Demos, produced a report with many different assumptions, including lower retirement savings rates. That study showed a lifetime loss in wealth of nearly $208,000 for an indebted household. About one-third of that figure came from less home equity, while the rest was from lower retirement savings.

He noted that about two-thirds of two-person households ages 24 to 30 have some retirement savings, and even they experience a big deficit by retirement. But it is those who have not saved anything — or cannot — that we ought to worry about the most.

Again, the case for college is clear. As my colleague David Leonhardt reported on The Upshot last month, the earnings gap between American college graduates and everyone else has never been higher. People with a diploma now earn 98 percent more per hour on average than those without a degree.

But let’s say your degree-less child is above average. So compare someone earning $45,000 a year (with the $29,000 or so in average student loan debt that Mr. Obama cited this week) with someone who makes $30,000 and has no degree. The higher earner still comes out ahead on savings even after repaying the loan.

This is true even if you assume, as Vanguard did when running this set of numbers, that the lower earner manages to set aside the same 8 percent of income. In this instance, the borrower puts much of that 8 percent toward debt payment and the rest toward retirement. Using the same set of assumptions about raises and returns as we did with the comparison between the two college graduates, the higher earner ends up with $1,607,849 upon turning 65, $225,677 more than the $1,382,172 that the lower earner saves.

So go to college. But parents of teenagers ought to consider several possibilities to keep their children out of debt and out of the eventual retirement savings hole: community college for two years instead of four years at a public university; working in college in lieu of additional debt; living at home during college; not taking on debt (especially private loans that aren’t from the federal government) to attend a more expensive college, even if it is a dream school. Our new student loan calculator, which appears alongside this article online, can help with estimates of average debt upon graduation at different colleges and universities.

Parents who want to assist their recent college graduates might consider doing so with contributions toward an Individual Retirement Account. And grandparents who expect to have a bit of money to pass on to heirs might advance some of that money to young adult grandchildren, who can benefit from a half-century of compounded interest if they put the money away and leave it alone.

If you’re in your 20s now and your employer matches savings in a workplace retirement account, do not miss out on that if you possibly can. Yes, interest is ticking away on your debt, but your employer’s contribution plus the years of compounding are worth that extra budgetary sacrifice.

On the topic of thriftiness and its necessity, savings ought to be possible for more people, even for those who earn salaries low enough to qualify for income-driven repayment programs like the one that President Obama expanded this week. Sandy Baum, a senior fellow at the Urban Institute who co-wrote a paper that contributed to the design of the federal income-based repayment programs, said that the sliding scale for monthly student loan payments should leave extra money for some retirement savings along with other core budget items.

Still tempted to compartmentalize and start saving money only after you’ve made the 10 years of standard student loan payments and gotten the nasty debt out of your life forever? That can be an effective psychological strategy. But if you want to do that and then make up for that decade of lost time on your retirement savings, reconsider our first scenario. Even if the person who starts saving at 32 saves at the maximum of $17,500 each year, the balance still ends up $121,792 short of the person who started saving at 22.

This is not the news anyone wants to hear. It is hardly fair that millions of young adults should be saddled with debt at the same historical moment when they’re increasingly responsible for paying for retirement and health care.

But this is the world we live in, where college is necessary but a mild five-figure student loan debt can lead the unaware into a six-figure shortfall later on.

A version of this article appears in print on , on Page B1 of the New York edition with the headline: High Cost to Focusing on Student Loans Over Saving. Order Reprints | Today’s Paper | Subscribe